Predicting Stock and Bond Returns: the Impact of Global Variables

Abstract

Prior research demonstrates that returns on US stocks and bonds over time can be predicted using models containing proxies for domestic business conditions and the stance of monetary policy. This paper has two objectives. First, it examines the benefits of adding international economic and monetary variables to US stock and bond prediction models. We specify a base model (employing US variables only), along with two alternative approaches that supplement or replace US measures with weighted average measures of corresponding variables based on the economic environment of the G‐7 countries. Monthly and quarterly holding period returns are examined over the time period August 1976 to December 1997. We conclude that, for some assets, using international information can improve forecasts of returns. The second objective of this paper is to re‐examine issues addressed in earlier studies using the international versions of our models. Our findings suggest that bond returns can be predicted with a common set of variables and that variables characterizing the monetary sector contain information about expected bond returns beyond that of business conditions proxies.